Saturday, January 24, 2015

The upcoming Greek election has renewed interest in the idea of Grexit. This option is often presented to the Greek public as desirable given that it would restore an independent monetary policy to the nation.

Beware, this is dangerous advice. The euro isn't a glove that you can take on and off, it's a Chinese finger trap; once in, it's tricky to get out. Even if Greece were to formally leave the euro, odds are that it would remain unofficially euroized, leaving it just as bereft of an independent monetary policy as before. The real trade off in a Grexit-or-not scenario is between formal membership in the euro with some say in monetary policy, no matter how small, or informal membership without any say whatsoever.

The optimists, say someone like Hans-Werner Sinn, advise the Greeks to leave the euro and adopt a new currency. The value of this new drachma would immediately collapse. As long as prices in Greece are somewhat sticky, Greek goods & services will become incredibly competitive on world markets, spawning an export/tourism-led recovery. By staying on the euro, however, Greece forfeits the exchange rate route to recovery. Instead, Greece's competitiveness can only be restored via a painful internal devaluation as wages and prices adjust downwards.

While the optimists tell a good story, they blithely assume a smooth switch from the euro to the drachma. Let's run through the many difficult steps involved in de-euroization on the way to an independent monetary policy. All euro bank deposits held at Greek banks must be forcibly converted into drachma deposits, and speedily enough that a bank run is preempted as Greeks desperately try to evade the corral by moving euros to Germany. At the same time, the Bank of Greece, the nation's central bank, needs to issue new drachma bank notes, the public being induced to use these drachmas as a medium of exchange.

Now even if Greece somehow pulls these two stunts off (I'm not convinced that it can), it still hasn't guaranteed itself an independent monetary policy. To do so, the drachma ₯ must also be adopted as the unit of account by the Greek public. Not only must financial markets like the Athens Stock Exchange begin to publish stock prices in drachmas, but supermarkets must be cajoled into expressing drachma sticker prices, employees and employers need to set labour contracts in terms of drachmas, and car dealership & real estate prices need to undergo drachma-fication.

Consider what happens if drachmas begin to ciruclate as a medium of exchange but the euro remains the Greek economy's preferred accounting unit. No matter how low the drachma exchange rate goes, there can be no drachma-induced improvement in competitiveness. After all, if olive oil producers accept payment in drachmas but continue to price their goods in euros, then a lower drachma will have no effect on Greek olive oil prices, the competitiveness of Greek oil vis-à-vis , say, Turkish oil, remaining unchanged. If a Greek computer programmer continues to price their services in euros, the number of drachmas required to hire him or her will have skyrocketed, but the programmer's euro price will have remained on par with a Finnish programmer's wage.

As long as a significant portion of Greek prices are expressed in euros, Greece's monetary policy will continue to be decided in Frankfurt, not Athens. Should the ECB decide to tighten by lowering interest rates, then Greek prices will endure a painful internal deflation, despite the fact that Greece itself has formally exited the Euro and floated a new drachma.

We know that a unit of account switch (not to mention successful introduction of drachma banknotes) will be hard for Greece to pull off by looking at dollarized countries in Latin America. To cope with high inflation in the 1960s and 70s, the Latin American public informally adopted the U.S. dollar as an alternative store of value, medium of exchange, and unit of account. Even after these nations' central banks had succeeded in stabilizing their own currencies, however, dollarization proved oddly persistent. This is referred to as hysteresis in the economics literature. Economists studying dollarization suggest that network externalities are the main reason for hysteresis. When a large number of people have adopted a certain standard there are significant costs involved in switching over to a competing standard. The presence of strong memories of past inflation may also explain dollar persistence.

In trying to de-euroize, Greece would find itself in the exact same shoes as Latin American countries trying to de-dollarize. Greeks have been using the euro for 15 years now to price goods; how likely are they to rapidly switch to drachmas, especially in light of the terrible performance of the drachma relative to other currencies through most of its history? Those few Latin American countries that have successfully overcome hysteresis required years, not weeks. If Greece leaves the euro now, it could take decades for it to gain its own monetary policy.

As an alternative illustration of the power of network externalities, consider the multi-year plans made by Slovakia (pdf, fig 2) prior to switching over to the euro, or the Czech Republic's timeline when it makes the changeover. Each step must be broadly communicated and telegraphed long ahead of time so as to ensure that all members of a nation are properly coordinated, thus ensuring the network effects engendered by the incumbent currency can be overcome. These euro changeover plans weren't adopted a few days before the switch, but often as much as a decade before.

In sum, I fail to understand how Greece can ever expect to enjoy the effects of a drachma-induced recovery if the odds of drachma-fication or so low, especially given the sudden nature of a Grexit. At least if it stays part of the euro, Greece has a say in how the ECB functions thanks to the Bank of Greece's position in the ECB Governing Council. And at least Greece's inflation rate and unemployment rate will be entered into the record as official data worth considering by ECB monetary policy makers. For just as the Federal Reserve doesn't consider Panamanian data when it sets monetary policy (Panama being a fully dollarized nation), neither would the ECB care about Greek data if Greece were to leave the euro, though still be euroized.

But the SNB is 45 per cent owned by private shareholders, many of whom are individuals, who receive dividends from the SNB. The rest is owned by the cantons, which have been complaining recently about insufficient cash transfers from the SNB.

Davies goes on to say that the influence of shareholders, combined with the peg, means that the SNB is particularly concerned about balance sheet losses. The idea seems to be that currency pegs often result in large balance sheet fluctuations, forcing a suspension of shareholder dividends.

I disagree, as a quick peek at the details shows:

1) The dividend to which Davies attributes so much importance is minuscule. In aggregate it comes out to just CHF 1.5 million per year, or US$1.7 million. Private shareholders, who own just 40.3% of the SNB's shares, are entitled to around 700,000 CHF per year in total. And these crumbs are shared among 2,219 private shareholders, most of whom hold ten shares or less. Are we to assume that these private interests care so much about the possible forfeiture of this trickle of cash (and just for a year or two) that they'd bother marshaling the significant effort required to influence Tommy Jordan, Chairman of the SNB, to drop the fixed exchange rate? Not a chance. These are nickles and dimes we're talking about.

2) Even if the shareholders organized themselves and tried to pressure Jordan, why would Jordan care? Jordan is Chairman of the three member Governing Board, which calls the SNB's monetary policy shots. He is appointed by the Federal Council, Switzerland's federal government, not by shareholders. Nor can the shareholders get him fired, as a quick reading of the National Bank Act reveals. Jordan can only be removed from office by the Bank Council. And while shareholders can elect five members to the Bank Council, the Federal Council, Switzerland's federal government, chooses the other six members, thus monopolizing the process. The upshot is that SNB shareholders have been neutered and exercise no control whatsoever over Tommy Jordan's thought process.

3) As for the interests of the Cantons, Tony Yates deals with them here.

I'm not sure why everyone is making such a big fuss of the SNB's corporate structure—it's hardly unique among central banks. The Federal Reserve, for instance, is 100% owned by private banks. We never worry about U.S. banks having an undue influence of U.S. monetary policy for the same reason we shouldn't worry about SNB shareholders having an influence on SNB policy—their power has been legislatively usurped by the government, as a quick reading of the Federal Reserve Act will show.

The deeper question is this: should the SNB (or any other central bank for that matter) take into account potential losses on its asset portfolio? In general, I think that the quality of a central bank's assets *should* be a factor that every central banker considers. If a central bank's assets have permanently ceased to yield enough income to cover the bank's salaries and expenses, then the central bank will have to cover this operating deficit by printing new money. Inflation will rise above target, forcing the central bank to sell assets in order to tighten the money supply. While this momentarily solves the inflation problem, it only further crimps the bank's supply of income-yielding assets and its ability to cover operating costs. A progressively slippier slope of ever more inflationary money printing to cover bills ensues.

This won't be a problem as long as the nation's government promises to recapitalize the central bank once problems emerge, thus topping it up with the resources to pay salaries and restore its inflation targets. Slippery slope avoided. But as I learnt a few years ago when reading a classic paper by Peter Stella, governments have been known to leave their central banks stranded. The Philippines' Bankgo Sentral is the best example of such a bank, the recapitalization it was promised by the government having been perpetually delayed. And as Stella points out, the central bank of Costa Rica has made losses for close to two decades consecutively, impeding the central bank’s ability to achieve low inflation. Prudence dictates a central banker be aware of the risk of being stranded.

All that being said, the SNB is really not at the point of having to be concerned about its operating position. The Bank's recent (and potential) losses are paper losses, not real ones. Bank expenses--including banknote printing, personnel, and overhead--still come out to just several hundred million francs a year, while its investments are providing billions worth of francs in interest and dividends. With Tommy Jordan's CHF 865,000 salary and all other expenses easily being covered, there's no slippery slope here. In sum, it is highly unlikely that the unhitching of the euro was motivated either by shareholder concerns or SNB worries about the effect of losses on its portfolio.

Friday, January 16, 2015

As many of you know by now, the Swiss National Bank (SNB), Switzerland's central bank, just reduced the rate that banks earn on deposits held at the SNB by half a percentage point to -0.75% (from -0.25%). The SNB had only recently instituted a negative deposit rate, having reduced it to -0.25% from 0% this December. The SNB will also be targeting a 3-month LIBOR rate of -1.25% to -0.25%, down from the previous range of -0.75% to +0.25%

The first is significant because as yet, no central bank has ever brought rates this deep into negative territory. The ECB's current deposit rate is set at -0.2% while Denmark's central bank, the Danmarks Nationalbank (DNB), applied a negative deposit rate of -0.2% on deposits that banks placed with the DNB in 2012. Neither of these top the SNB's ultra-low -0.75% rate.

The second point is significant because neither the ECB nor the DNB issue a note that approaches the real value of the CHF 1000.

Why is the conjunction of these two observations important? In short, we get to observe in real time how tightly the so-called zero-lower bound (ZLB) binds. When a central bank reduces the rate it pays on central bank deposits below 0%, arbitrage dictates that all other short term interest rates will follow along, including rates on government t-bills and insured bank deposits. However, one asset interferes with this adjustment: cash. Cash carries an implicit yield of 0%. If deposits or t-bills are being penalized at a rate of 0.25% per year, there are significant incentives for everyone to convert these assets into zero-yielding paper equivalents in order to avoid the 0.25% penalty. Not only will commercial banks all convert their deposits at the central bank to cash, but the public will clear out their bank accounts in order to hold paper. The upshot is that interest rates can't fall below 0% lest the entire country turn into a 100% cash economy.

In practice, the 0% bound isn't a tight one since paper currency incurs storage and transportation costs whereas electronic deposits don't. What this means is that a depositor will grudgingly accept a slightly negative deposit rate in order to avoid having to bear the inconveniences of ungainly cash. So the zero lower bound actually lies a bit lower than 0%, let's say -0.4%. However, reduce rates far enough below that and the dash to cash beings.

This is where the CHF 1,000 note comes into the picture. The larger the denomination of paper currency issued by a central bank, the lower the storage and transportation costs. Take CHF 1,000,000 worth of CHF 20 notes. That's 50,000 paper notes. The costs incurred in counting, double counting, checking for counterfeits, packaging, loading into an armoured car, unloading into a vault, paying storage costs on that vault, and finally insuring the hoard will be quite high. Now imagine CHF 1,000,000 worth of CHF 1000 notes. That amount to just 1,000 slim paper notes, a fiftieth of the amount. Handling and storage costs come out to much less. The point being that thanks to the CHF 1,000 note, the zero lower bound binds a bit more tightly in Switzerland than anywhere else in the world.

What I'd expect over the next few months is a mad dash out of deposits into these colourful bits of paper. Luckily, the SNB provides data on its note denominations, which I've charted below going back to 1990.

The value of CHF 1000 denomination notes in circulation. Source: SNB

You can see that in general, the value of CHF 1,000 notes outstanding has grown quite quickly since 1990 and now comprises around 61% of the entire value of the Swiss note circulation. While that tally retreated a bit in 2014, it should start to grow at an above-trend rate in 2015 now that negative rates are in effect. The actual process will go something like this; the Swiss public will ask to convert their bank deposits into CHF 1000 notes, the banks being obliged to provide these notes by going to the SNB and converting their SNB deposits into cash.

If this process doesn't occur, the implication is that the costs of holding 1000 notes are even higher than 0.75% a year, thus giving the SNB even more breathing room to reduce rates.

I'd expect ongoing conversion into 1000 notes to impose a significant burden on the SNB, threatening both the banking system's deposit base and the effectiveness of monetary policy. There are a number of fixes that the Swiss might consider to offset this burden. First, the SNB can bump interest rates back up in order to stem the mania for 1000 notes, hardly an alternative if it is trying to get inflation back up to its target. Alternatively, the Bank may decide to call in and demonetize the CHF 1000 notes, forcing everyone to accept five CHF 200 notes in its place (an idea discussed here). Since the 200 incurs more carrying costs than the 1000, the conversion into cash will be forestalled and the lower bound will have effectively been loosened downwards. Lastly, the Swiss might consider adopting a crawling peg between cash and deposits, as advocated by Miles Kimball.

The next and last option is the most interesting. When the public asks the banks for CHF 1000s, and the banks ask the SNB for 1000s, the SNB can just say no. In doing so, the SNB will have frozen the quantity of 1000s in circulation.

What will happen next will amount to an instance of Gresham's law. Since a CHF 1000 note is better than five CHF 200 notes due to its lower carrying costs, and 200s can no longer be converted on demand into 1000s thanks to the SNB's freeze, the 1000 should trade in the market at a premium to its face value, say CHF 1012 or 1013. However, legal tender laws typically stipulate that a note cannot discharge debts at more than its face value, thereby resulting in the forced undervalution of the 1000 note in trade. As a result, the Swiss public and its banks will hoard their 1000s rather than spending them, preferring instead to make payments and settle debts with lower denominations notes. Thus we get a modern version of Gresham's law, whereby 'good' CHF 1000 notes are driven out of circulation by 'bad' lower-denomination CHF notes. Think of it as an unofficial demonetization of the 1000.

Ultimately, I think that this last solution is the easiest and lowest cost alternative for the Swiss to fix their impending problem of mass paper storage at the negative interest rates. It's a temporary fix, however. A permanent solution will require outright demonetization of large denomination notes, or something like Miles Kimball's plan.

Sunday, January 4, 2015

John Cochrane writes an interesting post that makes the case that removing or penalizing cash would not remove an economy's 0% lower bound. Briefly, the zero lower bound problem arises when a central bank tries to reduce the interest rate on central bank deposits below zero. Because cash always yields a superior 0% yield, everyone will race to convert their deposits into cash, thus preventing a negative interest rate from ever emerging. By removing cash, this escape route is plugged and a central bank can safely guide rates to -4 or -5%.

Cochrane's point is that even if cash is removed, there are a number of alternative 0% yielding 'exits' to which people will flee, the effect being that rates will be inhibited from falling much below 0%. The examples he provides includes prepayment of taxes, bills, and mortgage payments, and the hoarding of gift cars or stored value cards like subway passes. In a follow-up post, he mentions a strategy of rolling over cheques.

There are two points I want to make:

1. Even with alternatives, a central bank can still create inflation

Scott Sumner points out that even in a cashless world at the zero lower bound, the existence of these alternatives cannot impede a central bank from driving up inflation. This is because the other alternative assets that Cochrane discusses are not media of account. To be a medium of account is to be that good which defines the $ unit that appears on a retailer's website and their aisles. What this means is that the the sorts of dollars that a retailer has in mind when setting sticker prices are those issued by the nation's central bank (in a cashless world, this would be central bank deposits). Retailers aren't using gift card dollars or stored value card dollars as the 'reference dollar' for their sticker prices.

Keep in mind that the use of central bank deposits as the medium of account does not preclude retailers from accepting gift cards in payment at the till. However, if they accept them, they'll probably apply some sort of reduction/addition to a good's advertised sticker price. If we assume that gift cards have become quite liquid in the absence of cash, I think it's conceivable that retailers would offer a reduction (ie. take gift cards at a premium) since gift cards would be a better asset than a deposit; in addition to being useful as media of exchange, they yield 0% rather than negative yielding deposits. We could imagine a range of different gift card premia developing based on their perceived quality, with cashiers consulting some sort of electronic guide to calculate the final bill.

In any case, Sumner's point is that as the central bank reduces rates into negative territory, sticker prices will all rise, despite the fact that alternative media exist that can be used to make payments. I think he's dead right.

2. Alternative escape routes will be resolved by simple product alterations, not a legal revolution

Cochrane's posts emphasize that in a negative rate world, all sorts of odd financial loop holes will be exploited in order to earn superior 0% returns. I think he's right on this. However, Cochrane seems to believe that that the government will have to upend 'centuries of law' in order to plug these alternative 0% instruments. I am more sanguine than him. If someone is exploiting a loophole in order to earn a superior 0% return, someone else is bearing that negative return. Institutions forced to bear the negative impacts of these loopholes will have an incentive to quickly evolve simple strategies to plug them, thus precluding any need for either Cochrane's rather dramatic 'legal revolution' or the heavy hand of the government.

Take Cochrane's first 'escape', gift cards. Consider a retailer that issues 0% gift cards in various denominations like $50s and $100s. Assume that in a world without cash, these cards have become relatively liquid. The central bank suddenly pushes rates to -5%. People who own negative yielding bank deposits will flock to buy the retailer's gift cards (assume that both instruments are equally risky) with the goal of immediately improving their expected return from -5% to 0%. The retailer, however, is left holding a -5% asset while owing a 0% liability, an awful position to be in. To remove the burden of this negative spread, our retailer need only reduce the return on newly-issued gift cards to -5%, say be introducing a redemption fee of 5%. A gift card worth $100, when redeemed, now only buys you $95 worth of stuff. Either that or just stop issuing the things. The loophole is closed and the problem solved.

The same goes for Cochrane's other 0% exit, prepayment if bills. A firm that allows for prepayments is accepting a 0% liability on itself; it effectively owes x dollars worth of some service or item. So we are back to our gift card example above, since gift cards are basically prepayments. Impose an appropriately sized fee on those who want to prepay and the problem is solved. Banks have always charged prepayment penalties on mortgages, car loans, and business loans, so this is nothing revolutionary in turning to this solution.

The next of Cochrane's 0% exits is a string of constantly renewed personal cheques. Rather than cashing a personal check, a cheque holder waits for that cheque to go 'stale', usually after 6-months, and then asks the issuer to issue a new one, rinsing and repeating as often as necessary. As physical bearer instruments, cheques (much like cash) cannot be made to pay negative interest, which allows the holder of a cheque to earn a perpetual 0% return. The unfortunate issuer of the cheque is left bearing a 0% liability in a world where their assets are yielding just -5%. This problem will quickly be resolved by people no longer writing checks. There is a less extreme alternative. Banks, unwilling to lose revenues from their cheques businesses, will simply increase cheque cancellation fees. Before a stale check is re-issued, it must be canceled, which traditionally incurs a cancellation fee. If the person running the scheme is required to pay an appropriately sized fee to carry over the cheque, the scheme can be rendered no more profitable than owning a -5% deposit.

Cochrane also points to Kenneth Garbade and Jamie McAndrews's scheme whereby depositors can purchase certified cheques from banks and thereby evade negative rates. According to Garbade and McAndrews, commercial banks "might find their liabilities shifting from deposits (on which they charge interest) to certified cheques outstanding," with this shift imposing significant costs on banks since certified cheques are less stable than deposits. If such a shift were to occur, banks would find themselves bearing a negative spread (liabilities yielding 0% while assets yielding -5%), a position they would be quick to remedy. One option would be to cease the issuance of certified cheques altogether. Alternatively, banks have always charged a fee for certified cheques. They could simply increase this fee to the point that the cost of holding a certified cheque is brought in line with the negative deposit rate. Once again, problem solved.

This fee strategy shouldn't be unfamiliar. It is the mirror image of the strategy adopted by U.S. commercial banks when interest rates were capped during the inflationary 1960s and 70s. Unable to reward depositors with sufficiently high interest rates, banks evaded the ceilings by offering implicit interest in the form of under-priced banking services, say by reducing fees on certified cheques. In our modern era in which deflation is pushing rates towards an equally artificial 0% barrier (in this case arising from the circulation of personal and certified cheques rather than a government imposed cap), all those services that a bank had been underpricing or pricing at market will now be adjusted upwards so that they are overpriced.

In sum, no revolutions here, just markets adaptation via boring old fee changes.

In closing, Cochrane has much more legitimate worries about two other problems: Big Brother and the disproportionate effect on the poor if cash is removed. Agreed, these are big issues. Now it could be that the emergence of cryptocurrencies such as bitcoin solves the Big Brother problem so that there is no role left for cash in preserving anonymity. Let's put bitcoin aside though. The simple answer to both of Cochrane's concerns is that we don't need an outright ban on cash to remove the 0% lower bound. Just adopt Miles Kimball's proposal for a crawling peg between cash and deposits. Kimball's peg is designed in a way that it would impose the same penalty on cash as that incurred by deposits. This would allow central banks to push rates to zero without mass flight into cash, all the while preserving the institution of cash for the poor and those requiring anonymity. (I've written in support of Kimball's plan here and here)

There is also my lazy man's route toward getting below the lower bound (here, here, here). I call it lazy since it's not nearly as complete as Kimball's solution, nor as complicated. Simply withdraw high denominations of bills like $100s, $50s, and $20s. When a central bank sends rates to -3% or -4%, people will balk at fleeing from deposits into $1s, $5s, and $10s since low denominations are very inconvenient to store. That way the poor still get to use cash and the zero lower bound can be breached.

Thursday, January 1, 2015

David Beckworth had a very interesting pair of posts outlining how QE would only have had a meaningful effect on the economy if the associated monetary base growth was permanent.

One addendum I'd add on the topic is that even permanent expansions of the monetary base can have no effect on the economy. The best example of this is the "cashing up" of the Reserve Bank of New Zealand (RBNZ) in 2006, an event that doesn't get the attention that it deserves in monetary lore.

Banks typically hold deposit balances at their central bank in order clear payments with other banks. Because New Zealand's clearing and settlement system was suffering signs of stress in the mid-2000s including delayed payments, hoarding of collateral, and increased use of the RBNZ standing lending facilities, the RBNZ decided to 'flood' the system with balances to make things more fluid. This involved conducting open market purchases that bloated the monetary base (comprised of currency plus deposits) from around NZ$6 billion in mid-2006 to just under NZ$14 billion by December of that year. See chart below.

(Note that the RBNZ's problems began far before the credit crisis and were due entirely to the peculiar structure of the clearing system, not New Zealand's economy.)

This 'cashing up' of New Zealand's monetary system was fast, large, and permanent, so New Zealand should have experienced extremely high inflation, right? Actually, New Zealand's inflation rate was very reasonable and even declined a bit that year.

Why is that? As long as central banks are allowed to provide interest payments to depositors, permanent increases in the monetary base needn't have much of an effect on the economy. Like most modern central banks, the RBNZ pays interest to commercial banks that keep balances on deposit at the central bank. So even if a central banker permanently amps up the supply of balances, banks will not all simultaneously try to offload this excess supply and hyperinflation does not follow. This is because the deposit rate 'carrot' that is dangled in front of banks helps offset their urge to get rid of the excess. In fact, even as it was cashing-up the system the RBNZ increased its deposit rate by 5 basis points five times between July and October 2006 for a total increase of 25 basis points, a slight tightening of monetary policy. This brought the return on central bank balances to a level competitive with other assets like government treasury bills. Instead of panicking as the monetary base permanently exploded by 150%, New Zealand's banks shrugged and calmly accepted the new balances.

When central banks don't pay interest on deposits then a permanent increase in the base will typically have a large effect on the economy. Without an interest rate carrot to make deposits competitive with other assets, banks that are faced with large excess balances will race to get rid of them, causing a large spike in the price level. With the U.S. Federal Reserve only earning the legal right to pay interest in 2008, there are now no major central banks (to my knowledge) that lack their own deposit rate carrot. And all of them set that rate to be roughly competitive with the rate on other short term assets like treasury bills, specifically a few basis points below the rate on competing assets.

Just to make sure I've made my point, with the deposit rate on central bank balances being (almost) competitive with other assets, a permanent doubling in the supply of money will only cause significant inflation when combined with a large cut to the deposit rate. Keep that rate unchanged and the same doubling will only have a marginal effect on the economy. A doubling in the supply of money would actually be deflationary if combined with a large enough rise in the central bank's deposit rate. In short, central bank decisions about the deposit rate can override whatever permanent changes are made to the money supply.

Beckworth makes the case that the Federal Reserve's quantitative easing was never more than a temporary measure, and therefore had no meaningful effects on the economy. I agree with him that QE didn't have much of an effect, but not necessarily because it was temporary. Let's say that QE was not a temporary phenomenon but rather more akin to a permanent New Zealand-style 'cashing up' of the system. If so, would QE's effects on the economy have been more marked? Given the precedent set by New Zealand in 2006, I don't think so. Throughout the Fed's three QEs, the rate offered on Fed balances (generally referred to as interest on reserves, or IOR) was very competitive with the rate on other government-issued short term assets, and therefore banks would have been unlikely to feel any need to rid themselves of their rapidly growing pool of balances. So while I agree with Beckworth that the Fed's 'dirty little secret' is that QE was muted from the start, I don't think that this powerlessness necessarily hinges on QE being temporary—after all, permanent increases can fall on deaf ears, depending on the level at which the central bank's deposit rate is set. New Zealand is living proof of this.

PPS. I'm not sure whether he'll agree with the following, though. Take the RBNZ again. It's 2006 and the Bank is paying a competitive rate on central bank balances. When it cashes up the system, the RBNZ simultaneously announces a regime change; it will now target 4-6% inflation rather than 1-3% inflation. It also says that the permanent increase in the supply of balances (and subsequent increases if necessary) will be sufficient to ensure this target is reached. The threat of a lower deposit rate will not be used to enforce the target, the rate being left unchanged. Will the RBNZ manage to hit its new target? I say no. Despite a regime change and a commitment to permanent open market operations, the Bank won't succeed in doubling inflation. This is because the unchanged deposit rate will be set too high, interfering with the RBNZ's ability to carry out its promise.

Two of my favorite posts that went pretty much under the radar screen were Fear of Liquidity and Liquidity Everywhere. Ignoring the fact that these titles sound like adverts for diapers, do give them a read.

Thanks to all you who comment on this blog. It's always fun to read your thoughts, they get me thinking about the next post.